Hey, I’m Dan Lane. I created this website and the Rental Income Podcast to help people learn how to generate passive income and build long-term wealth through rental properties.
Every week on the Rental Income Podcast, I interview an inspiring landlord to hear their story and to learn how they built their rental portfolio.
How Much Extra Money Can You Make With An ADU?
Dan: Michael, tell us what you’re doing with your rentals.
Michael: Yeah, what I’m doing is I’m purchasing properties that that would rent for about $2,500 or so a month in my rental market. And with some adjustments, I’ve been able to get that number up to $3500 to $4,000 a month in rental income.
Dan: Here’s what Michael’s doing. He’s buying single family houses, and instead of just putting one tenant in the property, he’s putting two tenants in there. One family rents the upstairs part of the house, and then he turns the basement into a separate apartment and rents that to an entirely different tenant. And in doing this, he’s taken a house that, after all the expenses, wasn’t really making that much money, and he’s turned it into a property that’s generating a tonne of cash flow.
ADU: An accessory dwelling unit, usually just called an ADU, is a secondary housing unit on a single-family residential lot.
Michael is going to share with us exactly what he’s doing. He’ll give us more details on exactly how this works, and hopefully, this will help you decide if this is something that you should consider. Joining us on the podcast today from Toronto is Michael Dominguez.
Michael, this idea sounds really interesting. Give us some more details. Tell me how this works.
Michael: Yeah. In my market, we have properties with full basements. Now I realise, depending on where people are listening, there are other opportunities. But essentially what I’m doing is I’m creating an additional dwelling unit in my home. So I’m taking a single family home and creating, in many cases, a one or two bedroom en suite. Now, in my case, it’s a basement and we’re turning it into a legal two unit dwelling or a single family home with an additional dwelling unit. And I’m getting wonderful tenants and it’s generating the kind of rental income needed to cover all of my expenses.
Dan: That’s really incredible. Okay. So are you having to do a lot of modifications to the basement? Because I guess the basement is almost like a full apartment. Correct. Do you have to do a lot of modifications? I guess you’re probably putting in the kitchen. Is there anything else that you’re doing in the basements?
Michael: Absolutely. In many cases, whatever is existing in this unit is being ripped out and started from scratch, because what I’m doing is I’m taking a larger box, which is a home, and I’m creating two smaller boxes within the first box. And each one needs to meet all of the fire and building codes of your municipality or state or province. So everything from fire safety and drywall, obviously, we’re creating a kitchen, a bathroom, one or two bedrooms, we’re creating an entire apartment. And there’s a lot of behind the scenes stuff, behind the wall stuff which is needed to create this suite.
But at the end of the day, it’s a one time expense. And not only is it getting the higher rental income, but it’s tremendously increasing the value. And in many cases, I’ve been able to refinance those properties based on the higher purchase or the higher value at that time and in many cases, getting my initial investment out of it.
Dan: How much are you generally spending to rehab the basement?
Michael: Yes, the numbers are changing constantly now, as we all know, with the supply chain issues, the labour costs and the material costs have been rising up tremendously. Now I’m in a 1000 square foot, two bedroom apartment may cost if I was hiring out a full contractor team and doing it all about $100,000 Canadian. We’re about $80,000 or so American. So big number. But at the end of the day, it’s raising up the value of my property by just that much in my market.
Dan: And then for the upstairs, do you generally have to do anything to the upstairs unit?
Michael: What I’m typically doing is obviously we’re doing the full fire separation, and I don’t want to negate that as being just, oh, yeah, I got to do that. But one of the things that’s most important if you’re going to be an investor in a long term landlord, is you want to make sure your properties are safe for whoever is living in those units. Following the rules and regulations set forth by your local government is integral. But the other thing I’m doing as well is in many cases, I’m adding en suite laundry right into each unit because I don’t necessarily want to have my tenants interacting with himself, with each other very often.
The other thing I need to do from the outside is in many cases, I’m getting a separate driveway or widening the driveway so that each unit has their own driveway opportunities. I can’t imagine one tenant knocking on the other tenants door at two in the morning wanting to get out. We have to separate it that way, right.
Dan: It’s almost like you’re turning the house into a duplex, correct?
Michael: Yeah. Actually, a lot of people misstate that by calling it a duplex. And the duplex is a purpose-built building, whereas this was built as a single-family home, and then it was retrofitted to have a secondary suite. So that’s where the additional dwelling unit or the secondary suite or whatever the term is in your market. But yeah, it’s like a duplex, but it’s not officially a duplex.
Dan: Now, you mentioned earlier that this is a legal process, so I guess that’s something that people should cheque on before they do this, because not every town or county is going to be okay with this. This is something that’s going to vary from area to area. So in your town, is there any kind of approval process that you have to go through to be able to do this 100%?
Michael: And it’s not a simple process. Obviously, the first time you do it, a lot of people compare it to giving birth. It’s a painful experience and you swear you’re never going to do it again. But once you get your bouncing baby boy, you say, oh, that’s pretty good. And then you decide you want to do it again and have a second child. And it’s honestly a lot like that as well. There are a lot of steps in the process, but once you’ve done it one or two times, it just gets easier because you know what the municipality or the city is looking for. But absolutely, there’s a lot of steps and a lot of legalisation and you nailed it when you said not every municipality can do this. Not every market is a quality market, and not every quality market allows you to be able to do the secondary suite opportunities. There are some markets in the United States, like Oregon, for example, or California, where they’re very onside with secondary suites. And then there’s others that are not so much.
Dan: Right? Yeah. And with a lot of areas, I’ve seen an actual detached unit that you can build, maybe in the backyard or something.
Michael: Absolutely. There’s coach houses, there’s the ability of adding an apartment above a garage. There’s the ability of replacing a garage with a secondary suite. There’s tiny houses. Every municipality has their own tweaks. In California, the big thing that people are doing is they’ve got a fairly large backyard and so they’re building sort of an extension to their backyard of building a one or two bedroom apartment that’s essentially it shares a common wall. So in that case there’s not nearly the fire separation between the two units because there’s this one wall, whereas the basement would have far more. Some people are building a secondary suite by, believe it or not, building if, let’s say it’s a one storey unit, they’re building a second storey above the first unit. So there’s multiple ways across North America where people are doing exactly that.
Dan: What about utilities? How do you deal with that? Do you have separate metres for each unit or is it one metre for the whole house?
Michael: The biggest cause of concern before I started to charge the tenant is I would show up at my property in the middle of February on the coldest day and meanwhile they’ve got their windows open because they want fresh air.
So how we account for it is if, let’s say it’s a bungalow, that’s three bedrooms and two bedroom basement apartment. What we’re doing is if, let’s say you’re the upper tenant, you’re paying essentially 60% of the utilities and I’m the lower tenant paying 40% of the utilities. How we’re doing the calculation for that is because we own a number of our properties, we know our utility bills tend to be about $400 a month, so we’re actually charging you. If, let’s say you’re paying the rent of $2,000, we may charge you $2,200 and you are essentially pre-paying the utility bill for that extra $200. And then I’m paying maybe another $150 or $200 on the basement. And then at the end of three or four months, we reconcile that and we find out what the actual bills were. And at that time you either get a credit for any overpayments you’ve done or you receive an invoice for anything that you’ve underpaid.
And the net result is that we’re essentially getting the utilities paid for by the tenants and we’re not out the money.
Dan: Right? I like that. I like that. Now let’s talk about the numbers again. I know you mentioned this at the beginning, so when you buy the properties, if you were just to rent it out the way it was without doing anything, how much would you get renting out the entire house?
Michael: A full house would rent for about $25 to $2,800 in my market. Plus utilities. That’s what people are willing to pay. They just can’t pay more than that. It’s just taking too much of their budget otherwise.
Dan: And then how is it broken down? Like, how much are you generally renting the upstairs for and how much? I guess the upstairs is 2500, but what about the I guess, are you getting 2500 for the upstairs.
Michael: That’s the whole advantage for the tenant too, because I’m able to attract a tenant people with incredible credit scores and people that are future home buyers, and why they would not rent the full house by my neighbour, perhaps, and rent my place is I might be offering that rent for they’re only getting the upper level now and they might rent it for 20, 21, 22. 00, depending on the location, the quality. So they’re saving 10% to 20% from what they’d be paying if they were renting out the whole house, including the basement. So they’re seeing a savings and it’s a win for them. And then the basement, because we’re getting a full basement apartment. The rent numbers are really strong.
In my market, there’s essentially zero vacancy, so we’re getting about $16,800 to the basement. So the end of the day, we’re getting anywhere from $3,500 to in one case, we’re getting $4,000 in rental income per month with the tenants paying utilities.
Dan: That’s incredible. Now, if you weren’t doing this, if you were just renting out the house regularly with the numbers work, like, would you be able to cover the mortgage and your expenses at $2,500 a month?
Michael: Yeah, those are what I call portfolio killers. And the challenge with that is I could probably do it because I have a pretty good nine to five income in the past, so I could have supported one or two properties, but the problem is that they would be absolutely negative cash flowing properties, and I’d have to dip into them every single month. And, you know, people can rationalise anything and they can say, Well, I could support the extra $1,000 in costs because these things are in great locations and they’re appreciating nicely. And that may be true, but the reality is that if bad stuff happens and you lose your job or you have a heart attack or a stroke or just some bad circumstances happen, you’re in a position where you can’t feel that extra few hundred dollars or that extra $1,000 a month in rental income, you’re forced to sell it. Whereas if I lost my job tomorrow, these properties are covering themselves and actually supporting me in some manner. And they’re not only appreciating by leaps and bounds because they’re a great market, but they’re also covering themselves cash flow wise.
Dan: I love it. And you’ve been able to do this multiple times, right? Like you’ve got multiple houses that you’ve done this to.
Michael: I don’t want to be a hands on investor. I don’t want to be constantly chasing people for rent. I’m looking for really great quality tenants. And how I do that is I look for quality properties in really good quality neighbourhoods that people want to live in. The people I want to rent to want to live there, and then they will be very attracted to my property because I’m renovating and fixing it well. And the net result is that I’m spending in many cases my portfolio. I’ve got twelve of these legal two unit dwellings. I don’t have to have a million properties to make my numbers work. I have a dozen. And even as little as two or three can change your life. And they’re appreciating. Well, they’re covering themselves. And then over time, as the rental numbers have been increasing in my market, the cash flow numbers have been getting historically better and better because obviously my mortgage and my taxes are pretty much staying the same or slightly going up. So I’m actually increasing my tax over time.
Dan: Yeah. I mean, it’s a really awesome strategy because they sound like these are like A class neighbourhoods that you’re buying it in. You’re buying an A class property, which is generally going to appreciate more than, like, say, a B or a C class property. You’ve got that extra appreciation in there. But what you’re generally lacking in an A class neighbourhood is the cash flow. But you’ve figured out how to get the cash flow and the appreciation all in one house.
Michael: Yeah, 100%. Just the kind of properties I am looking for is I know you live in the greater DC area and so what we’re looking for in a market is and let’s not talk about whether the municipality or the city will allow it. Let’s address that another time. But what I’m looking for in a market is something that where the town is seeing population growth, it’s seeing GDP growth, it’s seeing employment growth, and all of these things are pushing things upwards. And as more people are moving to that community, you’re seeing the rent numbers increasing, you’re seeing the property values increasing. The challenge with buying a property in a market, that’s tertiary market, where the values haven’t increased in a decade or two decades, like a Buffalo, New York, for example, is I could get a really great deal there and on paper I can get some incredible cash flow numbers. But the problem is that even if I do cash flow on that property, the odds of that property really jumping in value over time isn’t that good, because the demand just isn’t there. As population numbers decrease, the values just aren’t going up.
In my market, we’re seeing the population growing by 1% a year. It’s crazy growth here in the Toronto area. And as more and more people move to my community, my properties have become more and more popular and we’re seeing property, obviously, during COVID everything has been crazy. But since 2000, we’re talking 21 years here. We’ve been averaging about a 7% to 8% annualised growth over that time frame. So just simply riding the wave and cash flowing at the same time and seeing that kind of growth with the leveraging opportunities that real estate affords, it’s been a really lucrative investment for me.
Dan: Yeah, sure. Sounds like it. Have you always had the strategy? Have you always bought good properties in good neighbourhoods or did you ever venture into some lesser properties?
Michael: Yes. I wish I could tell you that I was smart enough to figure this out right away, but I did what everyone else did. And again, I’m not saying that their strategies are poor, but I did the strategy that everyone talks about. And the most common story is make it on the buy. If you don’t make money on the buy, you can’t make money in real estate. And I believe that to be a true statement. And so I bought poor properties that were in really poor repair in secondary and tertiary markets. And my first property I bought was a sixplex. And the second property I bought was a duplex on a busy street with very poor tenant profile. And I struggled and it almost broke me. I’m going to be honest with you, is I was doing this for a couple of years and I was constantly going to landlord tenant boards and dealing with crappy tenants. And it was really frustrating. It was becoming a full time job for me. And so it was almost like an AHA moment.
I had a mentor that sort of said, well, just buy the, you know, where the better properties are, why don’t you buy some of them?
And so honestly, I bought a couple of them almost by mistake. I got a good price or two and all of a sudden I saw the difference in the tenant profile and it was like a light bulb moment where I said, Geez, I should do more of that. And over time I’ve sold my properties that I wouldn’t purchase today and I’ve just kept the properties in the portfolio that are ones that I could see myself holding for five or ten or 20 years.
Dan: Wow. And today, with your A class properties, do you have any tenant problems at all or are all your tenants just kind of perfect tenants?
Michael: Well, I never want to say perfect, but I can tell you that I’m a semi retired or mostly retired realtor. And so I also helped a number of my clients purchase those type of properties as well. So we have not just my twelve properties times two of 24 tenants, but let’s expand that to over 300 properties in my market. So we’re talking 600, maybe even as many as 800 tenants. And so when COVID started, there was a real talk in big cities where landlords were not receiving their money. And so I reached out to a lot of my clients in March, April, May of 2020 to ask how many tenants were not paying the rent. And the answer was zero. Like there were a couple of tenants that hadn’t been paying the rent before and they were in the process of evicting. But zero tenants in all of my clients properties did not pay the rent. And I can tell you, I stopped asking people after about three or four months because it was just a waste of my time. But I can tell you in my personal portfolio not only I’ve had zero vacancies during the entire corporate pandemic but my rents have increased and I’ve had zero vacancies, zero vacancies, zero misrepresent, zero everything.
Dan: Michael has written a book called Armchair Real Estate Millionaire where he talks more about his story and kind of gives a template on how you can build long term wealth with rental properties. You can find it on Amazon or I’ve got a link to it on my website.